OPTIMUM GEARING LEVELS FOR UK REITS THROUGHOUT THE CYCLE: WHAT ARE - - PowerPoint PPT Presentation

OPTIMUM GEARING LEVELS FOR UK REITS THROUGHOUT THE CYCLE: WHAT ARE THEY , AND CAN THEY BE ACTIVELY MANAGED?

Society of Property Researchers Conference June 27th 2012 London

Consilia Capital 2012

Alex Moss Consilia Capital

ISSUES TO CONSIDER

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§ 1) Defining “optimum” gearing levels

§ Start at the asset level - At its simplest , the amount of leverage

required for underlying real estate portfolio to outperform i) equities , and ii) an absolute return benchmark?

§ The evidence throughout the period 1987-2011

§ 2) Are LTVs actively managed?

§ How do we judge? Passive management means LTVs are

determined by value movements at the asset level

§ The evidence throughout the recent cycle 2003-2011

§ 3) Issues affecting LTVS going forward

§ Practical issues to consider § Outlook for UK REITs

OPTIMUM GEARING

§ Methodology § IPD and FT All Share data from the last 25 years § Calculated relative performance on an ungeared basis § For years where real estate underperformed :

§ Assumed IPD Index income yield, then calculated the amount

• f leverage required to boost capital values to match All Share

Index

§ Repeated exercise with a total return benchmark

OPTIMUM GEARING LEVELS

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— How much leverage is needed to outperform the FTSE ALL

Share ? 14 years out of 25……none !

Source: IPD

OPTIMUM GEARING LEVELS

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— When should we add gearing? ê

OPTIMUM GEARING LEVELS

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— How much leverage is needed to outperform an absolute

benchmark – say 9% - 15 years out of 25 none !

OPTIMUM GEARING LEVELS

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— When should we add gearing? ê

OPTIMUM GEARING LEVELS

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— Over the 25 year period average 2.1% capital return 7.2% income

return FTSE All Share ave total return =7.3%

OPTIMUM GEARING LEVELS

— Initial conclusions: — Ungeared performance at the asset level is sufficient to

• utperform both UK equities and an absolute return benchmark

14-15 years out of 25

— Adding gearing could have improved this performance further,

BUT capital value changes were negative in 8 of the 25 years so gearing would not have improved relative performance

— In 3 years capital value changes were negative, but income

support was sufficient to generate outperformance

— Ungeared capital value movements are highly cyclical , and over

time are a small proportion of total return.

ARE LTV LEVELS ACTIVELY MANAGED?

— Methodology

— Take average LTV ratios for the UK sector (EPRA data) — On an annual basis calculate the impact on start of year LTV of

IPD capital value movements

— Compare to actual LTVs shown — Calculate for subsequent years — The difference between the two will show the extent of active

management

ARE LTV LEVELS ACTIVELY MANAGED?

• Results imply a level of active management

ARE LTV LEVELS ACTIVELY MANAGED?

• Initial conclusion of this is that while capital values have a

significant impact, the LTVs of the UK listed sector are not merely driven by capital changes, and at different stages of the cycle they have been actively managed to an extent, both to increase and decrease the ratio.

ARE LTV LEVELS ACTIVELY MANAGED?

— Recent examples

— 1) Increasing debt (via drawdown) to repay equity investors

(Unibail),

— 2) the issue of equity to maintain LTVs at manageable levels

(Eurocommercial)

— 3) taking debt off the balance sheet via a JV (British Land sale of

50% of Broadgate )

— 4) selling assets purely to reduce debt (the UK sector 2008-9)

MANAGING LTV LEVELS

— Practical considerations – equity valuation

• Dis. to NAV
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10 20 J a n

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Land Securities

LT Avg: -20.6

Pre REIT Status Avg: -23.6 Post REIT Status Avg: -16.8

MANAGING LTV LEVELS

— Relative cost of debt and equity

British Land

4.00 4.50 5.00 5.50 6.00 6.50 04-Jan-11 18-Jan-11 01-Feb-11 15-Feb-11 01-Mar-11 15-Mar-11 29-Mar-11 12-Apr-11 26-Apr-11 10-May-11 24-May-11 07-Jun-11 21-Jun-11 05-Jul-11 19-Jul-11 02-Aug-11 16-Aug-11 30-Aug-11 13-Sep-11 27-Sep-11

Bond Yield (4.999 2031 365MM ) Dividend Yield

OUTLOOK FOR UK REITS

— Historically LTVs have been in the range 35-65% — Going forward they are likely to be at or below the lower

end of this range because of:

— The lack of available bank debt — Greater focus on income rather than capital due to REIT

dividend payout rules

— Minimal capital growth projections — A desire from investors for secure cash (dividend) income

rather than cyclical unrealized capital growth

— A need for UK REITs to follow the example of US REITs

and actively use equity capital markets to finance expansion if the sector is to remain significant in a global context.